Detroit Bankruptcy Hinges On Treatment Of Different Creditors

By Michael Aneiro

In the wake of Detroit’s record municipal bankruptcy filing yesterday, a bunch of stories out today highlight how the case is going to hinge on the city’s treatment of different classes of creditors, particularly how holders of general obligation muni bonds may only get back pennies on the dollar and how that might ripple through the muni-bond market. Matthew Dolan reports in today’s Wall Street Journal:

So far, the city has an agreement to pay some secured creditors 75 cents on the dollar on nearly $340 million in debt. In exchange, the city would get back $11 million a month in tax revenue from the city’s three casinos originally used as collateral to back the debt. But negotiations with unsecured creditors, who were offered about $2 billion to cover $11 billion in debt, remain stalled….

Of particular concern to those in the municipal-bond market is the treatment of some of the city’s general-obligation bonds as unsecured, meaning they could be repaid at pennies on the dollar. This type of debt is considered one of the safest municipal investments. Harsh treatment may result in higher borrowing costs for cities and towns across Michigan, and potentially the U.S., market participants said.

Emily Glazer, Kelly Nolan and Michael Corkery report in a separate Journalstory that the bankruptcy kicks off a fight among more than 100,000 creditors over who gets paid what:

Most at risk in the bankruptcy case are those holding $11 billion in unsecured debt. The total includes nearly $6 billion in health and other benefits for retirees, more than $3 billion for retiree pensions and $530 million in general-obligation bonds. Because payments on such bonds often are backed by tax revenue and the pledge to raise it as needed for repayment, most investors consider the bonds safe and secure.

As a result, some municipal-finance experts object to Detroit’s decision to classify certain general-obligation bonds as unsecured debts, offering bondholders just pennies on the dollar for repayment. Critics claim the move could result in higher borrowing costs for municipalities across Michigan and possibly the U.S.

Last month Moody’s Investor’s Service called a restructuring plan offered by the city “unconventional and precedent-setting in the municipal market,” particularly in its planned treatment of creditors:

Detroit’s case is unique in that, given its high level of indebtedness, it is looking specifically to bondholders, in addition to unionized labor and pensioners, to solve the city’s severe fiscal problems. Detroit’s negotiations with creditors are also unusual in that the city proposes similar treatment of various debt security types that historically have enjoyed distinctions based on legal protections in state statutes and bond documents.

Amey Stone is Barron’s Income Investing blogger and Current Yield columnist. She was formerly a managing editor at CBS MoneyWatch, MSN Money and AOL DailyFinance. Her responsibilities included overseeing market coverage and personal finance topics. Prior to those roles, she was a senior writer at BusinessWeek where she authored the Street Wise column online and contributed to the magazine’s Inside Wall Street column. Topics covered included economics, corporate finance, Fed policy, municipal bonds, mutual funds and dividend investing. She co-authored King of Capital, a biography of Citigroup Chairman Sandy Weill. She is a graduate of Yale University and Columbia University’s Graduate School of Journalism.